Delaware Ruling: Can D&O Insurance Cover Fraud?

A recent Delaware Supreme Court decision has left many people asking: Can insurers be forced to pay settlements in cases where fraud is proven?

On the surface, the answer is “yes” after the March 2021 decision in RSUI Indemnity Company v. Murdock. Delaware did find that a D&O insurance carrier had to pay for a settlement linked to fraud.

But a closer look at this case reveals that the Delaware Supreme Court was far less interested in fraud and far more interested in two other things:

1. Asserting its jurisdiction in order to protect its corporate citizens
2. Strongly defending its corporate citizens’ right to contract freely

Holding that a D&O insurance carrier had to pay a settlement linked to fraud was merely a consequence; it was not the animating reason for the court’s decision.

So, the headline really is not “Delaware Courts Think Carriers Should Insure for Fraud.” A more accurate reading of the decision is that carriers know that big fraud situations often involve multiple pieces of related litigation; if a carrier wants a finding of fraud in one case to trigger the fraud exclusion for all related cases, the carrier can explicitly say this in the policy.

The other lesson? An insurance carrier that regrets writing an insurance policy contract with a Delaware corporation should not look to the Delaware courts to save the carrier from its own contract.

Background

Why did the D&O insurer think it had a chance to avoid paying the settlement in question? The answer relates to the egregious nature of the underlying matter.

The background of this story starts with Dole Food Co.’s CEO David Murdock and then-general counsel Michael Carter. In August 2015, the Delaware Court of Chancery found that they had breached their fiduciary duty of loyalty by committing fraud. (To avoid appeals that would have taken years to resolve, the parties subsequently agreed to resolve the case with a settlement.)

The fraud took place during a going-private transaction where Murdock and Carter worked together to drive the share price down by tampering with financial projections.

After a nine-day trial, the court found that that, due to Murdock and Carter’s fraud, the Dole shares were undervalued by $2.74 per share. As a result, Murdock and Carter were ordered to pay shareholders the difference between the price paid and the fair price determined by the court, a total of approximately $148 million.

(I wrote about this fascinating case previously, and you can read more about the Dole case here.)

Also in 2015, plaintiff shareholders filed a separate federal securities class action suit against Dole and Murdock for misleading investors in the going-private transaction in the United States District Court for the District of Delaware. In 2017, that lawsuit settled for $74 million.

Dole had an $85 million D&O insurance program consisting of a primary layer of insurance and several excess layers. In the course of this far-reaching, expensive litigation, the primary layer of insurance and all but the last excess layer of insurance were exhausted. The insurer that represented the eighth and final layer of insurance, however, resisted paying.

The question in front of the court was, could the last insurer in the D&O insurance tower avoid paying for the final securities settlement, because in a separate case involving the same set of facts, a Delaware state court had found that there was actual fraud?

The case goes back many years, and there are a lot of interesting details. For the purposes of this article, I’m going to discuss a few key points of the decision in RSUI Indemnity Company v. Murdock. For a more comprehensive overview, I recommend Kevin LaCroix’s article on this recent decision at the D&O Diary.

Delaware Jurisdiction

The carrier tried to argue that since it had issued its policy to a company headquartered in California, California—and not Delaware—law should apply. The carrier believed California law would favor the carrier given that there is a provision barring insurance coverage for “willful acts” in California Insurance Code Section 533.

Unsurprisingly, the Delaware Supreme Court was eager to assert its jurisdiction given that the insured party is a Delaware corporation. The principle? Don’t bet against the Delaware franchise. Or, as the Court put it:

… when we balance the California contacts against Delaware’s interest in protecting the ability of its considerable corporate citizenry to secure D&O insurance and thereby attract talented directors and officers, and for the other reasons mentioned above, we find that Delaware has the most significant relationship to the Policy and the parties.

Note that the carrier could have inserted a choice of law provision into its contract in favor of California, but it did not.

The Fraud Exclusion Trigger in the Policy

Skilled D&O insurance brokers—and their counterparts on the carrier side—have argued for years about what should cause the fraud exclusion in a policy to be triggered. In an earlier timeframe, I wrote about the need to avoid a two-front war when it comes to whether the fraud exclusion would be triggered.

Consider the situation of an embattled set of directors and officers being sued by their shareholders. The last thing the director and officer defendants want is to have their insurance carrier sue to have a court declare that, due to the allegations brought by the shareholders, the carrier does not have to advance legal fees and pay settlements.

Understanding that the D&O insurance policy was purchased exactly because shareholders may bring very serious allegations, most carriers readily agree to wait until shareholder litigation is resolved to determine whether the fraud exclusion is triggered.

When particularly bad facts are in play, it is typical to have multiple pieces of shareholder litigation brought at once, as happened in Dole’s case. However, notwithstanding the carrier’s protestations, the language in the Dole D&O policy reflected that a choice had been made as to what would happen to other litigation if one piece of related litigation resulted in a finding of fraud.

Specifically, according to the policy, the fraud exclusion was triggered upon a “final adjudication in the underlying action.” (Emphasis added.). As the Court noted, there was no final adjudication in the securities class action matter whose settlement the carrier was attempting to avoid paying.

The phrase “final adjudication” implies that a court of competent jurisdiction held a trial concerning the conduct in question, and all appeals concerning the outcome of that trial have been exhausted. A settlement, by contrast, occurs when the parties mutually agree to cease the court proceedings.

Consider that the carrier could have written the contract to trigger the fraud exclusion upon the final adjudication of “an” underlying action. If it had done so, then the finding of fraud in the related breach of fiduciary duty suit would, indeed, have triggered the fraud exclusion for all related claims. But the carrier did not do this.

Fraud and Delaware Public Policy

Having lost on both the law and the facts, the carrier also attempted to pound the table by arguing that insuring fraud should be against Delaware public policy.

The Court was entirely unsympathetic to the carrier’s extra-contractual efforts, but nevertheless provided a detailed analysis of the public policy issue raised by the carrier. The court began its analysis with the observation that “[w]e start our analysis reaffirming our respect for the right of sophisticated parties to enter into insurance contracts as they deem fit in the absence of clear indicia that a countervailing public policy exists.” (Internal punctuation omitted.)

The Court went on to observe that “[w]hen parties have ordered their affairs voluntarily through a binding contract, Delaware law is strongly inclined to respect their agreement, and will only interfere upon a strong showing that dishonoring the contract is required to vindicate a public policy interest even stronger than freedom of contract.”

As to whether Delaware has a public policy interest against insuring fraud that is stronger than the right to contract freely, the Court resoundingly declared that the answer is no.

Specifically, the court examined Delaware General Code Section 145 and found that while a Delaware corporation cannot indemnify for fraud, the Code imposes no such limitation on D&O insurance:

To the contrary, when the Delaware General Assembly enacted Section 145 authorizing corporations to afford their directors and officers broad indemnification and advancement rights and to purchase D&O insurance “against any liability” asserted against their directors and officers “whether or not the corporation would have the power to indemnify such person against such liability under this section,” it expressed the opposite of the policy RSUI [the carrier] asks us to adopt.

Implications and Consequences

As a result of this case, will directors and officers of Delaware companies suddenly feel casual about conduct that may breach the duty of loyalty, sounding in fraud? No.

Being accused of breaching one’s fiduciary duty is a serious allegation. Note, too, that the Dole officers who were found to have committed fraud were found to be personally, jointly, and severally liable for $148 million.

Will carriers start writing a lot of D&O insurance policies for Delaware corporations without a fraud exclusion? Likely not in the current D&O insurance market, but one could see this potentially happening over time.

I note that there are already some Side A policies that have no fraud exclusion. I would expect more companies to ask for the fraud exclusion to be dropped from their policies in the future, and some companies may even be willing to pay an additional premium for this. From a carrier’s perspective, however, this will surely be a difficult option to price.

Will carriers insert choice of law provisions into their insurance policies that attempt to avoid Delaware law? That seems likely, though insureds and the brokers will fight this as hard as possible.

Perhaps the most interesting question is whether the absence of the fraud exclusion could lead to more cases going to trial. After all, one of the oft-cited reasons for why more D&O cases do not go to trial is that directors and officers fear triggering the fraud exclusion.

At the margin, the absence of a fraud exclusion might encourage more directors and officers to take cases to trial. This is, however, only at the margin because the cost of going to trial both in terms of time and money will still be so significant. Settlements will almost always feel like the more efficient outcome. Also, directors would arguably have a fiduciary duty to settle a claim if there are insurance proceeds that could cover a settlement and avoid “bet the company” litigation.

Another observation is that most companies purchase D&O insurance contemplating settlements, not going to trial. If companies were contemplating going to trial, they would buy much bigger D&O insurance towers.

But, given the elevated price of D&O insurance in the current environment, it seems unlikely that buying habits will suddenly change in a way that will lead to larger D&O insurance towers. If the market softens, however, this calculus may change.